Tax agency in desperate need of extensive reform

Agam Fatchurrochman and Edi Suhardi, Jakarta

One of the puzzles of the Indonesian economy has been the tax office. True, the Directorate General of Taxation has played an important role as the prime motor of the economic engine and by consistently collecting more and more state revenue.

However, numerous studies on public and investor confidence in the tax agency, including studies by Indonesia Corruption Watch (ICW, 2001), Partnership for Governance Reform (Partnership, 2002), Transparency International Indonesia (TII, 2005) and Political Economy Risk Consultancy (PERC, 2005), have shown that the tax agency is consistently perceived as one of the most corrupt institutions in the country.

Sadly, there has been nothing in the way of a positive reaction by the tax office to these studies.

It is also true that since the last round of tax law reforms in 2000, the Directorate General of Taxation has introduced some major reform initiatives, including online payments, electronic filing and an integrated information system for tax administration. There also has been a joint initiative with the Ministry of Finance and the Commission of the Tax Ombudsman, which recently signed an agreement with the Corruption Eradication Commission (KPK) on law enforcement.

The idea behind these reforms was to simplify procedures and to strengthen the rule of law and social justice. However, these administrative and enforcement initiatives have not yet touched on the root of our taxation problems, which is tax extortion.

The most potent tax problem in developing countries is tax extortion, where tax officials actively look for economic rents. This is different from tax bribery, where a taxpayer initiates a bribe to receive concessions.

Coordinating Minister for the Economy Aburizal Bakrie, as a former chairman of the Chamber of Commerce and Industry, is well aware of this reality.

President Susilo Bambang Yudhoyono and his economic team have placed tax problems high on their agenda of action. The government should take two bold steps.

First, the privatization of the tax administration and audits. At a glance, this idea is perhaps revolutionary, although the philosophy of our tax collection, self-assessment and withholding (e.g. a company withholds employee income tax payments) is obviously a privatization concept, whereby the state entrusts tax collection to private institutions.

Further privatization is needed to cut direct contact between taxpayers and tax officials by privatizing tax audits. Direct contact between tax auditors and taxpayers is empirically proven to be the first contact for extortion. Therefore, in a situation whereby the reputation of the tax office is placed in severe doubt, the government and local trade associations can jointly assign an independent auditor to conduct a tax audit on behalf of the tax agency.

Consequently, there will be no contact between taxpayers and tax agents. Direct contact is entirely reduced to between the assigned auditor and tax agency. The tax agency still maintains the right to conduct peer reviews, where the tax agency can perform a review to ascertain the compliance of a tax auditor with audit standards, and, if necessary, can perform its own tax calculations by borrowing tax documents from the auditor.

This concept is not entirely new in our public finance practices. A precedent was when the Supreme Audit Agency (BPK) appointed PriceWaterhouseCoopers to conduct an audit on its behalf in the Bank Bali scandal. Other privatization cases include the government appointing Societe Generale de Surveillance, and later Sucofindo and Surveyor Indonesia, to conduct customs inspections of exports and imports on behalf of the customs service.

In addition, as a general precaution for preventing direct contact between taxpayers and tax agents, the government should encourage the practice of certifying tax returns by tax consultants who represent clients dealing with the tax agency.

The U.S. experience shows that tax consultants "enforce" clear-cut tax laws and "exploit" ambiguous tax rules by taking a pro-taxpayer stance. But tax compliance is higher when tax consultants are subject to harsh penalties for breaking tax laws. With so much at stake, tax consultants will act more as good "enforcers" and comply with tax regulations.

Consequently, the probability of collusive tax deals between tax consultants and tax agents is reduced and taxpayers will receive protection from tax extortion as well, since there is no longer direct contact with tax officials.

Second, legal steps must be taken to stop tax extortion by stepping up the roles of the KPK and the BPK. The KPK has the right to take over investigations of public complaints filed with the tax office. The commission can investigate the criminal aspects of tax extortion and question the origins of the wealth of the tax officials in question.

It also can work with the BPK to exert the BPK's semi-judicial power in pursuing state losses from tax extortion.

Finally, a medium-term systematic step should be initiated by modernizing the management of the tax office, including paying tax officials according to market rates for their skills, but threatening them with heavy penalties for corruption.

As a first step, spinning off the Directorate General of Taxation from the Ministry of Finance could be considered one viable remedial measure.

Agam Fatchurrochman is studying at Nottingham University's School of Business in the UK. Edi Suhardi is an observer on reform.